Sources of risks for SMEs

Insights into risk management

In today’s business landscape, SMEs face many risks for various reasons all throughout their business life cycles. As a first step, it seems appropriate to understand the meaning of risk, and what we at Populous World take into account in consideration to risk management with invoice financing.

Risks are the result of human actions and are not random. If properly understood, the exposure and impact of risks can be limited or even eliminated entirely.

Any event or action that could prevent the achievement of the objectives set or the implementation of the corporate strategy is considered a risk. Positive deviations are generally seen as an opportunity, while negative deviations are a risk. Opportunities are often considered in the strategic process. Negative deviations, on the other hand, are addressed in the risk management process.

Risks can derive from different environments

Generally, risks can be derived internally or externally. External risks are threats that arise from outside the corporate structure. Being risks that occur externally, these threats can be difficult to protect against. One of such risks is a natural risk which includes natural disasters.
Some sectors such as agriculture and fisheries are particularly vulnerable to weather conditions, but SMEs should note that such risks are not limited to just these companies. Natural disasters such as Hurricane Maria or the 2011 Earthquake in Fukushima are well beyond an SMEs control and can have major setbacks to a corporation’s business operations.

There are also political risks that can affect certain economic sectors. This can be due to tax and regulatory policies like the sugar tax that commenced in 2018 across the United Kingdom. In addition to this, a change in regulations such as Brexit can have an impact on SMEs and their business operations. This can affect them directly or indirectly as UK EMEs that trade with the EU will suffer from the adverse regulations while SMEs that do not trade with the EU may face difficulties in hiring or increased prices of raw materials.

As opposed to external risks, internal risks are risks faced by a company from within its organisation and arise during the normal operations of the company. SMEs in different industries will have different inherent risks and hence business owners must be well aware of the risks of their industries and company.

One internal risk that could be overlooked is a social risk, which includes employment. Depending on the type of industry, social risk can have different impacts. A dishonest employee in a cash till will result in a very different outcome to a business compared to a high-level employee in a huge corporation, as seen in the case of Barings Bank. On the flipside, cost of replacement of good employees will also be a risk that should be managed as it would cost betwen 20% – 200% of annual salary according to a study by the ‘Center for American Progress’. This could put a serious dent on the cash flow of the business, which leads us to our next internal risk.

One of the most emphasised risk for an SME is financial risk, where poor cash management can jeopardise the operations of an otherwise healthy company. Cash flow woes can be short and long-term, hence we implore SMEs to seek out expert advice on solving these problems, such as invoice finance as an alternative funding method. Depending on the circumstances, cash flow problems can sometimes be beyond the control of the business.

While an internal risk, falling demand and payment defaults which falls under commercial risks are of external origin. These are interlinked with financial risks, and while an SME can have a collections team, their debtor’s financials are out of their control.
For SMEs that are dealing with credit terms, debtors can sometimes pay late or default, which could impact an SME’s short-term cash flow position despite being insured. We recommend mitigating this risk by seeking short term cash flow solutions such as Populous World’s funding method that enables business owners to release working capital against their outstanding receivables, to aid the predicament.

In order to limit these risks, SMEs must develop a plan to reduce the impact of these risks on the economic health of the company.

Risk management practices are multiplying and developing in companies, particularly under the influence of new standards that place risk management at the heart of concerns. While large companies are more likely to adopt a holistic and formal approach, the issue is no less important for SMEs. On the contrary, risk management in SMEs can contribute to a certain partnership, organisational and entrepreneurial dynamic, providing a real opportunity to change practices and improve performance.

In preparation for the third installment to our risk articles, it is important to understand how risk management can be a lever for value creation and innovation for SMEs.

At Populous World, we are happy to speak to you to help with your business’s funding requirements. For more information, contact: [email protected]

Jeremy Carvalho
Credit risk analyst, Populous world.